Is the Latest Tesla Bond Issue a Sign of Trouble?

Is the Latest Tesla Bond Issue a Sign of Trouble?

Is the Latest Tesla Bond Issue a Sign of Trouble?

In a previous article, it was suggested that Tesla may need help flying the flag for battery-electric-vehicles (BEVs) in order to achieve their goal of truly disrupting the car market. This argument was based around other car manufactures committing to the market to help manage consumer expectations, improve the consistency of overall offerings of the BEV market and also the availability of compliments. Since, Tesla has said it is in the market to raise $1.5bn in senior unsecured notes, due in 2025, after losing $336m in its most recent quarter. Hardly the signal you’d expect from a market leader.

Tesla has just over $3bn in cash, but is burning through roughly $1bn a quarter (see below), with expectations that capital expenditures will be around $2bn during the second half of 2017 as they embark upon their self-proclaimed production hell. A production hell which will involve producing a new car in a new factory, and which will involve going from producing 0 cars, to 20,000 in December this year, to over double that a year later. Alongside this, it will need to manage its new Gigafactory (which will provide the batteries for the new mass market Model 3), and other products like the Powerwall.

Is this announcement a necessary step in achieving mass production, or a signal that Tesla isn’t as strong as previously thought, and that it is in fact in an overvalued, unrealistic bubble?

Tesla’s Questionable Business Model

Tesla has total debt of around $8.2bn, $4.7bn of which is long-term debt, according to FactSet. It rarely makes a profit and further expanded its negative cash flow to near $1.2bn last quarter (see below). This continuous reinvestment has aided the production of its current and new cars, and other products, and more recently, it has focused largely on R&D, increasing spending by 92% to $369.8m. The aim behind this is to shore up infrastructure and technology, with Musk believing it will make it even more difficult for competitors to catch up.

However, without delivering on his promises and consistently delivering BEVs which can rival conventional cars on performance and scale, he will fail to build the required bandwagon for the market (see Tesla Disruption; Can They Do It Alone). This will detriment not only Musk’s vision, but also the likelihood of Tesla being able to produce new models, attract investment and hold on to their supporters.

This announcement therefore seems to be an essential step for Musk; a step that allows him to scale up his production and make ‘milestone-based payments for Model 3 equipment and other products’, whilst avoiding the depletion of the company’s cash.

Alongside this funding, Tesla will also begin to receive money for their Model 3s as they are delivered. With 455,000 pre-orders already and with each customer paying $1,000 up front, Tesla is already beginning to receive a vital positive cash inflow of around $455m. Such demand can also almost guarantee that it will sell all of the vehicles they can produce not only this year, but also for all of 2018. As a result, many analysts believe that 2019 will be the year where Tesla turns profitable, with Reuters lightly ignoring the risks of this bond offering, arguing that ‘they should sell more than enough cars to make the leverage, and the additional interest bill, easy for bondholders to swallow’.

Not to worry then?

Musk a Speculative Credit Risk

Despite this positive outlook to his current cash flow problem, Moody’s Investors Service assigned Tesla a B2 corporate family rating and placed a B3 rating on the company’s offering of senior unsecured notes. Both ratings are ‘junk’, implying the company is of speculative credit risk.

Moody’s current model assumes Tesla succeeds in its Model 3 production ramp, but in doing so it won’t be fulfilling their 500,000 a year 2018 target, instead falling short by 200,000. A short fall which would raise concerns about Tesla’s production and infrastructural strength. Consequently, Moody’s assume that Tesla may be acquired if they stumble as ‘Tesla would have considerable value to another firm targeting the electric vehicle market’.

Standard & Poor’s Global Ratings supported this pessimistic opinion, affirming its B-minus rating on Tesla, saying that it poses significant ‘execution risks as they scale up production’. Perhaps supporters are over optimistic of Tesla and are ignoring the fundamentals.

Will Poor Fundamentals Drag Tesla Back?

Tesla last week reported a narrower-than-expected second-quarter loss and larger-than-expected sales, boosting its stock, which has risen by 67% this year. Tesla and Musk have wide-spread support, despite arguably poor fundamentals. It’s a car company yet to reach the mass market, has limited products, is financed heavily by debt, regularly misses production deadlines, and rarely makes a profit. Despite this, it is more valuable than Ford and GM in terms of market capitalisation (see below) and have a share price fluctuating around $365.

There is of course, a chance that this is a bubble, a bubble that might pop when Tesla encounter production issues as they scale up and begin delivering their new cars, whilst managing their other products. Musk himself has agreed that Tesla do not deserve their stock value and for a company with such poor fundamentals, their high value is questionable.

Tesla are spinning a lot of plates at the moment, and if one falls, the whole company may suffer, having a negative knock-on effect whereby they can’t reinvest in new models or products, consumers have doubts and they again fail to deliver what they promised in a market which is still yet to take off.

Investors Have Faith

Surprisingly though, given these models and ratings, there has been an early strong demand for the bonds, and there was a far from rash response in the market, suggesting that the majority of investors aren’t concerned by Tesla’s ability to meet their future projections and repay their debts. This is a regular occurrence for Musk after all having already raised $1.15bn in March this year.

After expressing the large risks that Tesla face, Standard and Poor went on to add that the boost to liquidity should offset such risks. It seems like for now, Musk’s ability to continually expand funding channels, shake off missed production schedules and work the bubble they have created is the very reason why it won’t pop.

Conclusion

If it is able to scale up production, deliver on the pre-orders, pull away from competitors and receive new orders, Tesla will soon become profitable. As they grow and again introduce more enticing products, they could begin to validate the value that the market has given them, hence reducing the concerns surrounding them.

However, they are about the embark on another ambitious trip, a trip that will no doubt have a few bumps to test the bubble along the way.

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